This is the third in a series of articles addressing commercial general liability insurance. The first article, published in the October 2008 issue, addresses whether claims alleged as a breach of contract are potentially covered by insurance. The second article, published in the December 2008 issue, discusses what constitutes an occurrence and whether claims alleging defective workmanship meet the occurrence requirement. Also, though it is Professional Roofing's policy to provide location information for companies mentioned in articles, some information is missing from this article because the companies in question no longer are in business.
Let's say a roofing contractor signs a contract to install a large roof system on a high-end shopping center in south Florida. A vast majority of the job consists of a low-slope membrane roof system, but there are certain areas where tile is to be installed. The roofing contractor hires a subcontractor to install the tile roof system.
Following construction, the tile roof system leaks. Efforts to stop the leaks are unsuccessful. The leaks damage tenants' inventory, and one tenant withholds rent, claiming he cannot use a portion of his leased space because of the risk of roof leaks.
The owner hires a roof consultant to investigate. The consultant concludes the leaks are a result of the subcontractor's use of the wrong type of tile and defective installation. To stop the leaks, the consultant recommends the tile roof system's removal and replacement. Meanwhile, the subcontractor has gone out of business.
The owner makes a claim against the general contractor, who, in turn, files suit against the roofing contractor. The claim against the roofing contractor includes damages for the cost to remove and replace the tile roof system, damage to the deck, damage to tenants' inventory and stock, and loss of rental income. The largest single component of the alleged damages, by far, is the cost to remove and replace the tile roof system. The roofing contractor has a standard commercial general liability (CGL) insurance policy. Does the roofing contractor have insurance for this claim and, if so, which of the alleged damages are covered?
What is the coverage?
To answer this question, remember CGL insurance provides coverage for bodily injury and property damage caused by an occurrence unless an exclusion from coverage applies. A CGL insurance policy obligates the insurance carrier to pay "those sums that the insured becomes legally obligated to pay" because of such damages. Assuming the occurrence requirement has been met, the damages must be classified as property damage and not excluded for insurance coverage to apply.
Standard CGL insurance policies define "property damage" as "physical injury to tangible property, including all resulting loss of use of that property" and "loss of use of tangible property that is not physically injured."
Viewed against the damages alleged against the roofing contractor, the damage to the deck, damaged inventory and lost use of leased space clearly fall within the definition of property damage and would be covered. Even though the roofing contractor did not directly cause these damages, the roofing contractor still is liable to the general contractor just as the general contractor is liable to the owner. Each of these items pertain to recovery of damages resulting from "physical injury to tangible property" or the "resulting loss of use of" the physically injured property.
But what about the cost to remove and replace the allegedly defective tile roof system?
"Your work" exclusion
CGL insurance policies contain an explicit exclusion for "damage to your work," commonly listed in the policy as exclusion 1. The "damage to your work" exclusion states the insurance does not apply to property damage to "your work" arising out of it or any part of it and included in the "products completed operations hazard." This exclusion does not apply if the damaged work or the work out of which the damage arises was performed by a subcontractor on your behalf.
CGL insurance policies define "your work" as "work or operations performed by you or on your behalf and materials, parts or equipment furnished in connection with such work or operations." The exclusion removes from coverage property damage to the insured's completed work caused by the insured's work.
Because of the "your work" exclusion, the cost to remove and replace a roof system typically would not be covered by a roofing contractor's CGL insurance policy; rather, it is the contractor's obligation to perform work in a good and workmanlike manner and make any needed corrections to his or her work without resorting to insurance. CGL insurance is not intended to cover the costs of correcting poor workmanship or defective products.
But what if the work in question was performed by a subcontractor?
The "your work" exclusion comes with an exception, stating the exclusion does not apply if the damaged work or the work out of which the damage arises was performed by a subcontractor on your behalf. An exception negates an exclusion, meaning that if an exception to an exclusion applies, the exclusion has no effect and the coverage otherwise provided in the insurance policy remains in effect.
Because the subcontractor exception to the "your work" exclusion specifically states the exclusion does not apply, the policy language indicates property damage to work performed by a subcontractor, unlike work performed directly by an insured contractor, would be covered under a CGL insurance policy containing the subcontractor exception.
Nevertheless, the case law that has developed regarding this subject has been mixed because of arguments from the insurance industry that there is no coverage for claims for defective workmanship when the only damage is to the contractor's work because defective workmanship is not an occurrence.
The exception's history
The standard CGL insurance policy has not always included the subcontractor exception to the "your work" exclusion. Before 1986, standard CGL insurance policies contained the "your work" exclusion without the exception, meaning if a subcontractor's work damaged the insured's completed work or was damaged itself, the insured contractor did not have CGL insurance coverage for damage to other portions of the insured contractor's work or to cover the costs to repair property damage to the subcontractor's work.
Although CGL insurance policies excluded coverage for work performed by or on the behalf of the named insured, during the early 1970s, the insurance industry began to offer a broad form property damage endorsement with language limiting the "your work" exclusion to property damage to work performed by the named insured.
Endorsements amend, replace, add to, reduce coverage or otherwise change the terms stated in insurance policies. If a contractor obtained the broad form property damage endorsement, the scope of the "your work" exclusion was limited so a subcontractor's work would not be excluded.
In 1986, instead of offering the broad form property damage endorsement, the insurance industry added the subcontractor exception to the "your work" exclusion as part of CGL insurance policies' standard terms. With the inclusion of the subcontractor exception, a contractor was able to gain the benefit of additional coverage related to work performed by subcontractors not previously included in standard CGL language.
The standard CGL insurance policy has not been modified since 1986. However, in 2001, the insurance industry began to offer two new endorsements to the standard CGL insurance policy. One endorsement eliminates the subcontractor exception on a blanket basis, and the other deletes the subcontractor exception on a project basis, effectively returning the CGL insurance policy to its pre-1986 status without the broad form property endorsement.
Court cases
In December 2007, the Florida Supreme Court in United States Fire Insurance Co. v. J.S.U.B. Inc. invoked the subcontractor exception to the "your work" exclusion in holding that the standard CGL insurance policy covered damage to the work of the insured general contractor caused by a subcontractor's defective work.
In this case, the insured general contractor, J.S.U.B. Inc., Fort Meyers, Fla., was a residential builder who used subcontractors to construct various portions of new homes it was building in a subdivision in Lee County, Fla. J.S.U.B retained a subcontractor for soil compaction work. After the work was completed, the foundations were poured and homes built. Subsequent to completion and sale of the homes, damage to the foundations, drywall and other interior portions of the homes appeared. The damages were found to have been caused by the soils subcontractor's use of poor soil and improper soil compaction and testing.
J.S.U.B. sought coverage under its CGL insurance policy for the damages. It was undisputed that the homes constituted J.S.U.B.'s completed work. Therefore, the "your work" exclusion applied. However, it also was undisputed the damage to the homes was a result of the work of J.S.U.B.'s subcontractor. Now, the subcontractor exception to the "your work" exclusion also applied.
While acknowledging there was insurance coverage for damaged personal property within the homes, J.S.U.B.'s insurance carrier, United States Fire Insurance, Morristown, N.J., argued there was no coverage. Using arguments that have been made with increasing frequency by insurance carriers in recent years, United States Fire Insurance said there was no CGL insurance coverage for faulty workmanship that results in reasonably foreseeable damages and is a breach of contract. The Florida Supreme Court rejected the insurance carrier's argument, finding J.S.U.B. had coverage for the damaged homes under its CGL insurance policy.
First, the Florida Supreme Court determined the damage to the homes constituted property damage caused by an occurrence. Then, the court found the "your work" exclusion did not apply because of the subcontractor exception.
The Florida Supreme Court quoted from a circular issued July 15, 1986, by the Insurance Services Office (the insurance industry organization that prepares standard policies) that discussed the changes in the 1986 standard CGL insurance policy and a treatise on insurance.
The circular stated the 1986 revisions to the standard CGL insurance policy not only incorporated the broad form property endorsement but also specifically "cover[ed] damage caused by faulty workmanship to other parts of work in progress; and damage to, or caused by a subcontractor's work after the insured's operations are completed."
The insurance treatise explained the reason for the 1986 revision adding the subcontractor exception to the standard CGL insurance policy: "[T]he insurance and policyholder communities agreed that the CGL insurance policy should provide coverage for defective construction claims so long as the allegedly defective work had been performed by a subcontractor rather than the policyholder itself. This resulted both because of the demands of the policyholder community (which wanted this sort of coverage) and the view of insurers that the CGL was a more attractive product that could be better sold if it contained this coverage."
In another 2007 case, the Supreme Court of Texas in Lamar Homes Inc. v. Mid-Continent Casualty Co. applied the subcontractor exception to the "your work" exclusion. Again, in this case, a residential homebuilder sought insurance coverage for damage to a home resulting from a subcontractor's defective work. Similar to the Florida Supreme Court, the Supreme Court of Texas ruled the contractor's CGL insurance coverage applied to the damages to the home based on the subcontractor exception even though any damage to the home would otherwise have been excluded by the "your work" exclusion. Courts in Kansas, Minnesota, South Carolina, Tennessee and Wisconsin have issued similar rulings.
In Auto Owners Insurance Co. Inc. v. Newman, the Supreme Court of South Carolina ruled in March 2008 that replacement of a subcontractor's defective work was covered under the standard CGL insurance policy.
In this case, the general contractor subcontracted out portions of the homes' construction, including the application of stucco as the homes' exterior coating. After construction, water intrusion problems arose out of defective workmanship related to improper stucco application. The water intrusion damaged the homes' framing and exterior sheathing.
After determining the policy covered the property damage because of the application of the subcontractor exception to the "your work" exclusion, the court went on to hold that the repair and replacement of the stucco was a covered property damage. The court said because the underlying moisture damage could neither be assessed nor repaired without first removing the entire stucco exterior, the removal and replacement of the defective stucco was covered.
Who is a subcontractor?
Although the subcontractor exception provides for coverage if the damaged work or the work out of which the damage arises was performed by a subcontractor, CGL insurance policies do not define who is a subcontractor. As a result, courts have had to determine who is considered a subcontractor.
Following a well-established legal principle that ambiguities in insurance policies are to be broadly interpreted in favor of coverage and exclusions from coverage are to be narrowly construed, some courts have taken an expansive view when determining who is a subcontractor.
In the 2004 case Wanzek Construction Inc. v. Employers Insurance of Wausau, the Minnesota Supreme Court ruled a material supplier to the insured general contractor was a subcontractor for purposes of the subcontractor exception to the "your work" exclusion.
In this case, the insured general contractor, Wanzek Construction Inc., Williston, N.D., contracted with the city of St. Louis Park, Minn., to construct a municipal swimming pool. To perform its contract, Wanzek Construction entered into a standard purchase agreement with Aquatic Designs Inc. to design, fabricate and deliver precast coping stones, create shop drawings and provide on-site supervision of the coping stone installation by Wanzek Construction's employees for either three days or until the employees felt capable of performing the installation.
After the pool was completed, a number of the specialty coping stones cracked and St. Louis Park demanded Wanzek Construction replace the failed stones. The company called upon Aquatic Designs, but Aquatic Designs refused and later filed for bankruptcy.
Wanzek Construction then was forced to pay $164,162.64 to replace the coping stones and submitted a claim to its insurer, Employers Insurance of Wisconsin, Wausau, Wis., who denied the claim on the grounds the cost of remedying defective work was not covered by CGL insurance. Wanzek Construction, seeking coverage for the cost to replace the coping stones, relied on the subcontractor exception to the "your work" exclusion.
The court ruled a supplier who custom fabricates materials to the owner's specifications and provides on-site services in connection with materials installation qualifies as a subcontractor under the subcontractor exception. Therefore, Wanzek Construction was entitled to recover its loss from its insurance company.
In a 2001 roofing case, the Superior Court of Delaware reached a similar decision. In AE-Newark Associates L.P. v. CNA Insurance Cos., the Superior Court of Delaware recognized Johns Manville, Denver, could be a subcontractor for purposes of the subcontractor exception to the "your work" exclusion.
In this case, Delco Roofing Co. Inc. and Delco Siding & Gutter Inc. were contracted to remove, install, replace and/or reroof roof systems on 14 buildings at an apartment complex in Newark, Del. The roof systems installed by Delco Roofing leaked and damaged the apartments and tenants' personal property. Delco Roofing was insured by CNA Insurance Cos., Chicago, who disclaimed coverage for the faulty roof systems, claiming the losses were excluded because the damage resulted from Delco Roofing's work.
The court found the roof systems installed by Delco Roofing were authorized, designed and engineered by Johns Manville. The damage to Delco Roofing's work was allegedly because Johns Manville failed to provide Delco Roofing with a protective water sealant and instruct Delco Roofing to apply a protective coating.
Whether Delco Roofing's CGL insurance policy provided coverage hinged on whether Johns Manville was Delco Roofing's subcontractor. In ruling insurance coverage applied to the faulty roof systems, the court considered Johns Manville a subcontractor and stated the "your work" exclusion did not apply because the exclusion is inapplicable if the damages result from a subcontractor's performance.
Because of the allegation that the damage resulted from Johns Manville's failure to properly apply a weather sealant or instruct Delco Roofing to apply such a sealant, the court applied the subcontractor exception to find that CNA Insurance was obligated to provide coverage.
Although courts in many states apply the same approach as the Florida and Texas courts, some courts have, in effect, disregarded the subcontractor exception in construction defect cases when the insured general contractor or developer seeks insurance coverage for damage to a portion of a building caused by defective subcontractor work.
In these cases, insurance carriers have been able to avoid the intention and effect of the subcontractor exception by arguing the subcontractor's defective work and subsequent damage to other work is not an occurrence, and, therefore, the general contractor's CGL insurance policy does not apply. As a result, the subcontractor exception to the "your work" exclusion is not considered because an exception to an exclusion in an insurance policy is not to be used to find coverage.
A recent example is the May 2008 decision of an Illinois Appellate Court in Stoneridge Development Co. Inc. v. Essex Insurance Co. Stoneridge Development, a residential homebuilder, subcontracted the entire building process and operated as a construction manager. On one development, the site required soil compaction before building. The soil compaction was performed, and the construction of townhomes completed. Subsequently, there was significant damage to the townhomes because of failing footings that were attributed to unstable subsurface soil.
Stoneridge Development sought coverage from Essex Insurance, Glen Ellen, Va., its CGL insurance carrier. In arguing the CGL insurance policy did not provide coverage, Essex Insurance focused on whether the subcontractor's defective work constituted an occurrence. Essex Insurance argued that because there was no property damage to anything other than the completed townhomes, which was Stoneridge Development's work, there was no occurrence.
The Illinois Appellate Court found in favor of Essex Insurance. The court reasoned that had the subcontractor's work damaged something other than a townhome, such as personal property within the townhome, the subcontractor's defective work would have constituted an occurrence, but because the damage was limited to the townhomes and no other property was damaged, no occurrence took place. The court went on to state that because there was no coverage, the "your work" exclusion and the subcontractor exception were irrelevant based on the principle that an exception to an exclusion will not create coverage.
In the roofing case ACS Construction Co. Inc. of Mississippi v. CGU Insurance decided in 2003 by the Fifth Circuit U.S. Court of Appeals, the court ruled a general contractor's CGL insurance policy did not cover repairs to its roofing subcontractor's defective work.
In this case, ACS Construction, Winter Park, Fla., contracted to build munitions bunkers for the U.S. Army Corps of Engineers. ACS Construction hired a subcontractor to install the waterproofing membrane. After completion, leaks developed and ACS Construction incurred costs to repair the subcontractor's work. ACS Construction called upon its insurance carrier, CGU Insurance, to cover the costs of the roof repairs. The court ruled the roofing subcontractor's defective work did not constitute an occurrence and, therefore, the subcontractor exception to the "your work" exclusion was irrelevant.
Courts in Indiana, New Jersey, Pennsylvania and Virginia have issued rulings similar to those in the Stoneridge Development and ACS Construction cases. These cases, each involving a general contractor's CGL insurance policy, had outcomes that the subcontractor exception has no meaning or effect. The important point to keep in mind when considering the effects of these cases is the insured contractor in each case is a general contractor whose work consisted of an entire building. These cases do not pertain to a subcontractor who calls upon its CGL insurance carrier to provide coverage when there are interior damages or damages alleged to other parts of the building or work performed by others.
From an insured subcontractor's perspective, the damages to other work typically would trigger CGL insurance coverage. These cases do not provide that the subcontractor who damaged the general contractor's work would not have CGL insurance coverage for the loss.
Check your policy
Although courts have been inconsistent in applying the subcontractor exception, you should know CGL insurance policies contain a subcontractor exception to the "your work" exclusion. To gain the exception's benefit, check with your insurance advisers to see whether your CGL insurance policy includes the post-1986 subcontractor exception and that it does not include endorsements that remove the subcontractor exception.
Jared W. Heald is an attorney and Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.
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